Struggling businesses push for bankruptcy law in Egypt

Image of Egyptian pound used for illustrative purpose.

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Business Monthly

By Tamer Hafez

Back in 1980, Salah (not his real name) bought a small furniture factory in 6 October City, where he also ran a showroom where he sold tables and chairs. In the following decades, as business thrived, he added production lines and nearly doubled his workforce to 500 people. In recent years, however, cheap, globally mass-produced furniture imported from countries like China and Sweden became increasingly popular in Egypt, and local manufacturers like Salah went under in droves.

By 2009, Salah was struggling to repay a total balance of LE 43 million plus interest in bank loans he had taken out back in the mid-1990s, when business was booming. One day in late December, he received a 6 a.m. phone call from his lawyer instructing him to report to the police. “I knew my finances were in a mess,” says Salah, but he insisted that in the past, the banks had always been accommodating about accepting partial or delayed payments, so long as he kept them in the loop. So he was shocked to learn that one of his creditors had filed a formal complaint that he’d defaulted on his loan and called in the balance—LE 20 million. Without the funds to comply, Salah was ordered to spend the night in a temporary holding cell while his wife scrambled to raise the money for his LE 250,000 bail.

And that was only the beginning of Salah’s ordeal. The cops padlocked the doors to his factory and froze his bank accounts. He was told that his assets would be auctioned off, with the proceeds going to his creditors. Nor had Salah seen the last of prison. Between 2010 and 2015, the businessman was imprisoned four more times, for two-week stints, and he says his family has paid nearly a million pounds in total to bail him out of jail. Six years later, at 63, he is still in the process of negotiating a settlement with the banks, while his factory remains shuttered and all his assets frozen. “Thankfully, my wife has her own business,” he says, “and she has been supporting the family.”

His story is not unusual. Without a specific law governing bankruptcy, Egyptian businesses that run aground financially have long had no choice other than to be evaluated by the courts on a case-by-case basis, often facing the specter of imprisonment for unpaid debts. In an attempt to remove this hefty barrier to risk-taking and investment, Egypt's Cabinet on Jan. 4 approved a draft law regulating bankruptcy, the country’s first such legislation. According to a Cabinet statement, the law will “deal with cases of faltering companies and merchants to fulfill their obligations.” While details of the draft law, now before parliament, have not been published, the Cabinet said the law is “within international standards” and “ensures the rights of all parties” including creditors, debtors and employees.

Crucially, proponents say, the legislation would end jail time for debtors and offer options in which distressed businesses can stay open. “This new bankruptcy law will work in tandem with the new investment law,” to attract foreign investors back to Egypt and help revive the economy, said Minister of Investment Dalia Khorshid, who has since been replaced by Sahar Nasr.

The issue has come to the fore as local businesses, already struggling after five years of economic crisis following the 2011 revolution, are coping with the additional hit of the Central Bank’s float of the Egyptian pound in November, a move the government and international agencies like the International Monetary Fund agree was a bitter-but-necessary economic reform measure. Meanwhile, the float has put the survival of many local businesses in jeopardy. In particular, companies that took on dollar-denominated debts in recent years in order to pay for imported supplies and equipment when the CBE held the exchange rate below LE 8.8 are now facing skyrocketing repayment costs, with greenbacks soaring to more than LE 19 in recent months. (The rate was around LE 16 at press time.) Importers in particular are teetering at the brink of insolvency.

In December, nine local investors associations took out a full-page ad in state-run Al Ahram calling on President Abdel Fattah el-Sisi to take “emergency measures” to help local businesses. In the ad, the businessmen argued that an estimated 2 million jobs are at stake if their member companies shut down for failure to pay back an estimated total of $10 billion in debt. Meanwhile, the Federation of Egyptian Industries has asked the CBE and individual banks to revise the repayment schedules for businesses with dollar-denominated debt and/or accept repayment at the pre-float exchange rate without requiring additional collateral. “After two years of currency and economic havoc,” says Mohamed Shaaban, chairman of the 6 October City Investors Association, scores of Egyptian companies are one shipment away from insolvency. “We don’t have pockets that deep anymore.”

Even firms that haven’t suffered a drop in business are facing a financial squeeze due to the massively devalued Egyptian currency. Trader Mohsen el Gedamy took out a $900,000 loan last October to import dried beans for the upcoming Ramadan season. “Now the bank is calling me nonstop” demanding an additional LE 8 million before it will release the dollars to pay Gedamy’s suppliers. “I don’t have LE 8 million to set aside for this shipment,” he says.

Currently, virtually all advanced economies, and many developing ones, offer some form of recourse for businesses and/or individuals who are unable to repay their debts. In Egypt, currently, debtors are more or less legally at the mercy of their creditors and their willingness to accept revised repayment terms. If the banks don’t feel like being flexible, the courts have the power to seize and liquidate a debtor’s assets—down to his home and his car—in order to repay creditors.

Over the years, a handful of high-profile businessmen have fled the country after being prosecuted for enormous unpaid debts. Ramy Lakah, a local tycoon with holdings in construction, health care and aviation who was elected to parliament in 2000, left Egypt after defaulting on somewhere between LE 1.2 to LE 1.4 billion he owed mainly to state-owned banks. Lakah still lives in France, where he owns several businesses, though his lawyers in Egypt are reportedly still negotiating with his creditors. Others, however, seem to have somehow avoided prison even while facing ongoing charges connected to their debts. In January, the media reported that a court had handed over most of Ahmed Bahgat’s Dreamland Group, which includes an entertainment park, a residential compound and a TV network, to the National Bank of Egypt and Banque Misr after the banks accused him of failing to pay LE 4 billion in arrears.

The problem is this punitive approach makes Egypt less attractive to investors. The World Bank, in its “Doing Business Report 2017” ranks Egypt 109th among 190 countries in “resolving insolvency,” noting that creditors recover an average of 27 cents for every dollar lent, compared to 73 cents in OECD countries. The cost of going under in Egypt sucks up around 22 percent of distressed companies’ assets, compared to 9.1 percent in advanced economies, and the proceedings take an average of 2.5 years compared to 1.7 years in OECD nations.

Officials are pitching the new bankruptcy law as a cornerstone of reforms that aim to make Egypt more investor-friendly. According to those who’ve seen copies of the draft, the legislation would allow the debtor to present a plan for staying in business during bankruptcy. A court-appointed mediator would handle negotiations between creditor and debtor with the aim of restructuring rather than liquidating distressed businesses.

Officials told reporters that Egypt’s draft law was modeled largely on the U.S. bankruptcy law, which operates on the free-market principle of encouraging entrepreneurship by allowing businesses “the freedom to fail.” There are numerous kinds of bankruptcy in America, the most well-known being Chapter 11, which allows distressed businesses to restructure and continue operations while shedding their debts to banks, employees and suppliers—not uncommonly in less than a year. Notable examples of corporations that have reorganized under Chapter 11 include auto giant General Motors, which filed for bankruptcy in 2009 after reporting that it had $82.29 billion in assets and nearly twice as much—$172.81 billion—in debt. While GM’s was the fourth-largest bankruptcy in U.S. history, it remains one of the world’s largest auto makers. During a Republican presidential debate in 2015, would-be President Donald Trump boasted that he filed for bankruptcy four times between 1991 and 2009 on behalf of various enterprises.

Unsurprisingly, the local business community has largely welcomed the draft law, saying an up-to-date bankruptcy code is long overdue in Egypt. “It will solve a longtime nightmare for Egyptian businesses,” says Mohamed Al-Bahey, a board member at the FEI, adding that the new law should help promote the creation of new business and encourage informal enterprises to join the formal economy. “The fact that an entrepreneur taking a risk on the market can face jail if they get it wrong has always been a strong deterrent to small businesses,” says Ahmed Mashhour, chairman of the Egyptian Junior Businessmen Association.

“It’s about time that the government presented such a law to us,” agrees Hesham Emara, a member of the parliamentary economic committee and an economics professor at Damanhour University, pointing out that Egypt lags behind a number of developing economies in sub-Saharan Africa that have reformed bankruptcy laws to give insolvent companies the option of a second chance via reorganization. “We can’t continue to talk about new investment while the shadow of prison looms over investors who go bankrupt,” says Emara.

Mostafa el Nasharty, deputy dean of the economics school at Misr for Sciences and Tech University worries that the potential downside of passing such a law now is that offering Egypt’s struggling businesses an exit pass will be all too tempting in the current climate. “The enforcers of the new law will be tested to the extreme right away,” he predicts.

Salah, the beleaguered former furniture maker, is confident his factory would still be running today—still employing hundreds of people and contributing to the economy—had he been given the option of reorganizing under bankruptcy protection. But back in 2009, Egypt’s economy was relatively strong and investors’ confidence was high. “Now,” he admits, “I might think it safer to exit the market and try again later.”